A Growing Cancer in Fiscal Policy
With the furor surrounding Trump’s impeachment trial, and the growing national security risks caused by his dangerous forays into foreign policy, most people aren’t thinking about the deficit and national debt. But make no mistake. Like a silent but rapidly progressive cancer, the unprecedented, uncontrolled escalating deficit and debt can be deadly.
Understanding the Deficit
Perhaps trying to understand the deficit usually makes your eyes glaze over. But it’s really pretty simple. A deficit occurs when spending exceeds income. If you face that dilemma in your personal life, you know that short of winning the lottery or robbing a bank you’ll have to change the way you’re living. Even if you have a family member or friend who takes pity on you once or twice, no one is likely to make up your shortfall every month. Most of us have to take stock, decrease our discretionary spending, look for a better paying job or a second job, and move ourselves and our family to less expensive housing. If we ignore the problem and keep spending more than we earn, or the remedies aren’t sufficient, the likely end result is personal bankruptcy.
This is an easily understood concept when it is confined to individual people and businesses. Though businesses can and do obtain financing from banks (like people), they also borrow money from other financial institutions, shareholders and owners. Ultimately though, they must demonstrate they can generate a profit (and positive cash flow) to repay their loans. And if they can’t generate sufficient revenue to cover their expenses, they can’t escape bankruptcy. No company, big or small, is exempt from this rule of economics. Consider, for example, the infamous bankruptcies of General Motors, Chrysler, American Airlines, Macy’s and thousands of Mom and Pop stores across the country.
Recognizing this reality, most states require a balanced budget. If preliminary anticipated revenue is insufficient to cover budgeted expenses, the state’s government must fix it. They add new taxes or fees to raise money coming in or reduce and/or eliminate certain programs or operating expenses.
The Federal Government’s Approach to Deficits and Debt
On the other hand, the federal government is something like a trust fund baby that sees no reason to feel constrained or to limit itself. As crazy as it seems, the U.S. Government can cut taxes and keep spending as long as Congress approves it. Historically, Congress has approved budget deficits for most years of the Country’s existence. To finance those deficits, Congress borrows funds, creating what we refer to as the national debt.
In 1791 the United States had accumulated debt of $75.5 million, or about $2.0 billion in 2019 dollars. That’s a far cry from the debt of $22.3 trillion at the end of 2019. One trillion is a thousand billion, or a million million! It’s a mind-boggling number. But the Country has been operating with deficits since its very first days as a republic, and the debt has steadily increased. Yet we’re still afloat. So does that suggest deficits don’t matter? Before I address that question, here are some obvious conclusions.
Evaluating a Country’s Debt.
The Country pays interest on the money it borrows. If we incur a deficit and borrow more every year, the deficit gets bigger and the ballooning debt can never be repaid. Most economists agree that the best way to evaluate the quality of a country’s debt is to compare it to the total value of goods produced and services provided in that country during one year. In other words, they look at the country’s debt as a percentage of its overall economic output, or Gross Domestic Product (GDP). That comparison is called the debt-to-GDP ratio, and is determined by dividing the debt by the GDP.
A World Bank Study in 2010 concluded that a debt-to-GDP ratio in excess of 77% over an extended period of time could adversely affect economic growth. That’s the point when lenders become concerned about buying the country’s bonds and its ability to repay its loans. Aside from the 1940’s war years through 1951, the U.S. remained well under that level. Then we had the debt crisis in 2008 and a recession that threatened to sink into a depression. Since then, the debt-to-GDP ratio has steadily increased, reaching a high of 106% in 2019.
Financing U.S. Debt
Financing for that debt comes from two sources: the public and other-government agencies. Americans and foreign investors hold the public debt—like a bank holds an individual’s mortgage. The country’s principal foreign investors are Japan and China. Government agencies that raise more in taxes than they spend, such as the Social Security Trust Fund and Military Retirement Fund provide the rest. But money borrowed from other government sources are real loans and must also be paid back.
Do Deficits Matter?
But enough with numbers, let’s get back to the central question. Do deficits matter? The answer often depends on which economist you speak to and whether they’ve been influenced by conservative or liberal philosophies. For example, during an economic downturn, some conservative economists might call for governmental austerity to reduce the deficit. More liberal economists favor increased government spending, believing it will spur the economy. Of course, there are always differences in how to do that. Republicans favor tax cuts, while Democrats favor investments such as in infrastructure and education.
Some will argue that deficits don’t matter because, unlike many other countries whose debt is denominated in U.S. dollars, the U.S. debt is in its own currency. Some foolish individuals would assert that we could just “print more money.” However, anyone who’s taken Economics 101 knows that increasing the money supply just makes each dollar worth less. More money is available to purchase the same amount of goods and services. The laws of supply and demand step in, inflation takes over, and voilà, a loaf of bread costs $15.00.
The Impact of Growing Debt
In the real world, deficits create more debt and more debt means increased interest payments. Today, interest rates are very low, which to some extent compensates for the increased amount of debt on which interest must be paid. But over time interest will take up a greater percentage of the U.S. budget, crowding out other badly needed government programs. Ultimately, the consequence of continual deficit spending will be an increase in interest rates that adversely affect economic growth.
Even worse, if and when the economy goes south, the full arsenal of tools to combat recession conditions will not be available. Since current tax rates are already insufficient to provide necessary revenue and have proven they are incapable of generating accelerated growth, further reductions in rates is a non-starter. This situation exemplifies the folly of the Republican ideology of lowering tax rates when rates are historically relatively low and the economy is already in a growth mode. That is the time to reduce deficits to decrease the national debt.
The 2017 Tax Cuts
It bears repeating to point out the 2017 tax cuts have failed to produce accelerated economic growth. Corporations have not made their promised investments to fuel economic expansion. Instead, many have used their tax savings to buy back their own stock. Tax cuts for the wealthy were—and are—an inadequate economic stimulus. Perhaps a rising tide lifts all boats, but when it comes to a tidal wave of wealth for the wealthy, it leaves the poor and middle class to drown.
On the other hand, investing in infrastructure stimulates the economy and puts people to work. Those workers will spend what they earn and create a multiplier effect of more new jobs. “Research shows that spending on bridges, roads, and public buildings creates the most jobs per buck invested. The next best is education spending.” But the short-term cost will be a massive increase in deficits and the national debt.
The justification for the Republican tax cuts in 2017 was as much of a canard then as it is now. “It will be rocket fuel for our economy,” Trump promised. “The tax plan will pay for itself with economic growth,” Treasury Secretary Steven Mnuchin said. In fact, the economy grew 2.9% in 2018 — exactly the same as in 2015. In 2019, the economy grew 2.3%, the least since 2016, and again, for the second year in a row, below the Trump administration’s 3% target.
I count myself among those who predicted a different result than that promised by Trump and his Republican sycophants. [See my 2017 blogs: Taxes and More Hypocrisy; You Can’t Have Guns, Butter And Tax Cuts; Tax Cuts – No Sense and Nonsense; Tax Cuts and Job Act – Monstrosity, Outrage, Scam]
Where Do We Go from Here?
The point of this story is that the current level of deficits cannot continue without seriously damaging the U.S. economy. According to a February 2019 report from the non-partisan Congressional Budget Office, the federal budget is on an unsustainable and damaging fiscal trajectory. And that was based on an estimated budget deficit of $897 billion in 2019. The deficit turned out to be in excess of $1 trillion. So where do we go from here?
First, we step back and look at the debt-to-GDP ratio. While I’m no math genius, I know that to reduce the ratio, we must either lower the amount of debt (the numerator) or increase the GDP (the denominator). To lower the debt, we must, of course, first eliminate the deficit. Spending less is certainly an important aspect of deficit reduction, but today I will focus on our tax laws.
Initially, corporate and individual rates should return to pre-2017 levels. Additionally, fundamental changes have to be made in taxation of corporations and the wealthy. In my May 2019 post, Capitalism, Greed and Taxes, I recommended certain changes in tax law. They are as relevant today as they were then, and I repeat them below.
Make Believe Accounting and Changes in Tax Law
Corporations maximize profits in low or no tax jurisdictions through make believe accounting. They record or change normal transactions to realize tax savings, rather than economic or legal considerations. For example, a valuable patent might be placed in a low tax jurisdiction (Ireland), but a royalty for its use is charged in a high tax jurisdiction (United States). The result: higher profits in the low tax jurisdiction and lower profits in the high tax jurisdiction.
The same technique is used to price manufactured goods and transfer higher costs to high tax jurisdictions. So, the very first step on the road to a remedy is to require that the substance of all transactions must be based on economic or legal factors, not tax avoidance.
Here is a sampling of special tax provisions that should be eliminated. They are commonly known as tax loopholes, and don’t reflect economic reality:
1. Laws that were specifically written to lower the taxes of a particular corporation—usually achieved by the efforts of highly paid lobbyists;
2. Provisions that allow businesses, such as those in commercial real estate, to pass on to their heirs an asset’s appreciated value without that appreciation ever having been taxed.
These two examples of tax loopholes that don’t reflect the Country’s economic needs, yet are widespread throughout our tax system. All such special provisions need to be closed unless there is an overriding real economic or security reason to maintain them. Common wisdom has it that paying the least amount in taxes is the smart thing to do. It’s good for the bottom line. And while that may be true, it’s short-sighted and not good for the rest of us. American corporations need to pay their fair share in supporting the Country that gives them an opportunity to use the roads and bridges, hire a workforce and thrive.
Taxation Based on Actual Economic Profit
Virtually all businesses prepare annual financial statements. The Securities and Exchange Commission (SEC) requires publicly owned companies to file quarterly and annual reports of specific financial information. Most sizable, privately owned businesses provide similar information to their banks and/or insurance company. Such financial information includes an income statement that reflects the company’s “book” profit, certified by the company’s independent accountants.
Based on industry wide Generally Accepted Accounting Principles, book profit is, perhaps, as close as it gets to real economic profit. This differs significantly from taxable income reported to the IRS, principally because of the sorts of special tax provisions described above. Since it is the reported book profit that generally drives the company’s progress, it is this number that should become the basis for taxation.
Accordingly, there should be an Alternative Minimum Tax on Corporations based on a percentage of the actual “book” profit of all its U.S. entities.
If all tax loopholes were eliminated the book profit and taxable profit would be approximately the same. But that is not realistic. So, the company’s tax bill should be the greater of the Alternative Minimum Tax or the tax as calculated with existing special provisions (deductions). Except for a real economic book loss, no corporation should walk away with a zero-tax bill.
Wealthy Taxpayers
Many wealthy individuals accumulate their vast wealth while earning very little in salary. Therefore, they are not subject to ordinary income tax rates. So, higher tax rates on the wealthy, alone, will not solve the problem of widening economic inequality. Nonetheless, those rates should be raised. Again, the issue of special provisions rears its head to allow wealthy taxpayers to shield their income from taxation.
Investments in real estate, stocks, art and other assets can appreciate until they are sold. However even in circumstances indicated above, certain appreciated assets can be passed on to heirs without being taxed. Special provisions such as accelerated depreciation or untaxed appreciation of asset values should be eliminated.
In the absence of their elimination, there should be a revision of the individual Alternative Minimum Tax for wealthy taxpayers. Deductions arising out of special provisions such as those described above should be added back to income to produce adjusted alternative taxable income. Then a percentage should be applied to that amount to produce an Adjusted Alternative Minimum Tax.
Just as with corporations, no individual should walk away with a zero-tax bill.
The Consequence of Growing Deficits and Debt
Recent news reports reveal that wealthy donors who stayed away from providing Trump financial support in 2016 are now doing so. Anecdotally, I have seen the same behavior from some business people of considerably more modest means. They cite a good economy and stock market, but in actuality they’re happy paying less taxes and making stock market windfalls.
The negative consequences of Trump’s fiscal policy aren’t apparent yet, but are nonetheless real. No one knows how or when too much debt will affect the economy. But all business cycles of economic expansion eventually end and economies contract. When that happens—and it will—government will not have the best tools available to stimulate the economy.
If you think economic conditions were bad in the 2008 recession, let me provide you with the prescient words of Al Jolson, the famous American entertainer, actor, and singer who starred in the first feature-length film with sound, The Jazz Singer. “You ain’t heard nothin’ yet.”
So, to those who are now benefiting from Trump’s fiscal policy, enjoy your “sugar high.” Your children, grandchildren and future generations will not. They will have to repay the debt Trump’s misguided (and selfish) fiscal policies have exacerbated and newly created.
That’s aside from the long-term consequences of Trump’s other policies, including national security, health care, women’s rights, immigration, climate change, moral degradation of the presidency, destruction of our national values, and democracy itself.
If you’re paying attention, you’re worried. You should be. I am.
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